New Rules for Those Plans Required to Provide QJSA and QPSA Notices
NEWS
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- The Pension Funding Equity Act of 2004; Internal Revenue Service Notice 2004–34 and Announcement 2004–38
In December 2003, the IRS issued regulations regarding the content of qualified joint and survivor annuity (“QJSA”) and qualified pre-retirement survivor annuity (“QPSA”) notices. Under previously issued regulations, defined benefit plans, money purchase pension plans and certain other defined contribution plans subject to Internal Revenue Code (“Code”) § 401(a)(11) were required to provide general QJSA and QPSA explanations which:
- described the eligibility conditions and the material terms of the optional forms of benefit available to the participant;
- included additional information to explain the relative values of these optional forms of benefit in comparison to the QJSA; and
- explained the relative financial effect of electing the optional forms of benefit.
The previous guidance, however, did not explain how plans should determine and disclose relative value.
While maintaining the requirements of the previous guidance, the newly issued regulations specify how the relative value of optional forms of benefit must be expressed. The regulations are intended to provide participants with enough information to enable them to compare the values of the distribution forms available to them. They are applicable to QJSA distributions with annuity starting dates on or after October 1, 2004 and to QPSA explanations provided on or after July 1, 2004. However, since QJSA explanations must be provided no later than 30 days and no more than 90 days prior to the annuity starting date, the revised QJSA explanations may be required as early as July 3, 2004. If a plan provides for retroactive annuity starting dates, the date of the commencement of payments will be treated as the annuity starting date for purposes of determining the applicability of the regulations.
Regulatory RequirementsUnder Treas. Reg. § 1.417(a)(3)–1, QJSA explanations must be written in a manner calculated to be understood by the average participant and must contain either participant-specific information or generalized information based on a hypothetical participant at representative ages. If a plan opts to provide generalized explanations, the explanations must also include a statement regarding the participant’s right to request information about the participant’s specific benefits under the plan. (See the section “Generalized Explanations” below for further information about the use of general notices.)
If a plan provides participant-specific explanations, the explanation must include with respect to each optional form of benefit available:
- A description of the optional form of benefit;
- A description of the eligibility conditions for the optional form of benefit;
- In the case of a defined benefit plan, a description of the financial effect of electing the optional form of benefit (i.e., the amount payable under the form of benefit to the participant during the participant’s lifetime and the amount payable after the death of the participant);
- A description of the relative value of the optional form of benefit compared to the value of the QJSA; and
- A description of any material features of the optional form of benefit.
When preparing QJSA explanations, instead of providing different QJSA explanations that vary according to marital status, a plan may use the same form of benefit (single life annuity or QJSA) for both married and unmarried participants. For a married participant, a plan may use the single life annuity instead of the QJSA to compare the value of the optional forms of benefit available, provided the single life annuity is available to that married participant. Likewise, for unmarried participants, a plan may use the QJSA instead of the single life annuity to compare the value of the optional forms of benefit available, provided the QJSA is available to that unmarried participant.
Relative Value DisclosuresUnder the regulations, relative value disclosures must be written so that participants may meaningfully compare the relative economic value of the optional form of benefit to the QJSA without having to make calculations using interest or mortality assumptions. To meet this standard, a plan may provide any of the following numerical comparisons:
- A plan may express the actuarial present value of the optional form of benefit as a percentage or factor of the actuarial present value of the QJSA (e.g., the lump sum is 90% of the value of the QJSA);
- A plan may state the amount of the QJSA that is the actuarial equivalent of the optional form of benefit and that is payable at the same time and under the same conditions as the QJSA (e.g., the actuarial equivalent of the lump sum would be a QJSA of $400 per month as compared to the actual QJSA of $500 per month); or
- A plan may state the actuarial present value of both the optional form of benefit and the QJSA (e.g., the present value of the lump sum is $40,000 and the present value of the QJSA is $50,000).
Relative value disclosures may be simplified if the distribution forms available to a participant have approximately the same value. If a participant is entitled to two or more optional forms of benefit that have approximately the same value (i.e., none of the actuarial present values of the optional forms vary in relative value in comparison to the QJSA by more than 5 percentage points), the optional forms of benefit may be grouped together. By grouping the distribution forms together, a plan can satisfy the relative value disclosure requirement by comparing the relative value of any one of the optional forms in the group to the value of the QJSA and disclosing that the other optional forms are of approximately the same value. If any of the optional forms in the group is a lump sum distribution, the lump sum distribution must be used in the comparison.
If optional forms of benefit may be grouped, the relative values for all of the optional forms can be expressed using a representative relative value for the entire group. This value is any relative value that is not less than the relative value of the member of the group with the lowest relative value and is not greater than the relative value of the member of the group with the highest relative value when measured on a consistent basis. Hence, if three grouped optional forms have relative values of 87.5%, 89% and 91% of the value of the QJSA, the three optional forms can be treated as having a relative value of approximately 90% of the value of the QJSA. If one of the three grouped optional forms is a lump sum distribution, the 90% representative value must be disclosed as the approximate relative value of the lump sum, while the other optional forms can be described as having the same approximate value as the lump sum.
If the participant is also entitled to elect an optional form of benefit that cannot be grouped with the other available optional forms of benefit, the relative value of that optional form of benefit must be expressed separately from the grouped forms.
Special Grouping RulesIn addition to the above grouping rules, the regulations include the following two special grouping rules:
- If a plan compares the value of each optional form of benefit to the value of the QJSA for a married participant and any optional form has a present value of at least 95% of the present value of the QJSA, the optional form may be described as being approximately equal in value to the QJSA; and
- If a plan compares the value of each optional form of benefit to the value of a single life annuity and all optional forms have present values that are at least 95% but not more than 102.5% of the present value of the single life annuity, the optional forms may be described as all being approximately equal to the single life annuity.
To prepare relative value comparisons, the regulations require the following:
- With respect to optional forms of benefit that are subject to Code § 417(e)(3) and Treas. Reg. § 1.417(e)–1(d) (i.e., lump sums), a plan must use the applicable mortality table and the applicable interest rate as defined in Treas. Reg. §1.417(e)–1(d)(2) and (3) (or another reasonable interest rate and reasonable mortality table if the plan uses these assumptions to calculate the amount payable under the optional form of benefit); and
- For all other optional forms of benefit payable to a participant, the plan must use a single set of interest and mortality assumptions to compare the optional forms with the QJSA, provided the assumptions are reasonable and are uniformly applied with respect to all such optional forms available to that participant. The assumptions used need not be the actual assumptions that are used by the plan to determine benefit payments.
Note: Although the regulations specify how numerical comparisons of relative value must be calculated, the regulations do not have any impact regarding a plan’s separate obligations under Treas. Reg. §1.401(a)–20, Q&A–16. This section requires that the QJSA for married participants be at least as valuable as any other optional form of benefit under the plan. The preamble to the final relative value regulations provides that the regulations in no way require that plans use the same actuarial assumptions for purposes of disclosing relative value that are used in complying with the requirements of Treas. Reg. §1.401(a)–20, Q&A–16.
Explanation of the Concept of Relative Value and the Disclosure of Assumptions UsedThe following additional information must be provided in the relative value disclosure:
- An explanation of the concept of relative
value. The explanation should state:
- that the comparison is intended to allow the participant to compare the total value of distributions paid in different forms;
- that the relative value comparison is prepared by converting the value of the optional forms of benefit to a common form (such as the QJSA or a lump sum distribution);
- that the conversion uses interest and life expectancy assumptions; and
- A statement that all comparisons are based on average life expectancies and that the relative value of payments made under an annuity optional form of benefit will depend on actual longevity; and
- The actual interest rate used to prepare the relative value comparison. If optional forms of benefit are grouped, the interest rate need not be disclosed for any optional form of benefit that is not subject to Code § 417(e)(3) and Treas. Reg. § 1.417(e)–1(d)(3) (i.e., lump sum forms). If such interest rates are not disclosed, the explanation must include a statement regarding the participant’s right to obtain the interest rates upon request. Thus, if a plan participant is entitled to elect the lump sum distribution form, the plan must include the actuarial assumptions used to calculate the relative value of the lump sum distribution form in the explanation.
Use of Reasonable Estimates
To satisfy the financial effect and relative value disclosure requirements, a plan may use reasonable estimates, including reasonable estimates of the applicable interest rate under Code § 417(e)(3), reasonable assumptions for the age of a participant’s spouse, and reasonable estimates based on data as of an earlier date than the annuity starting date. If a plan uses reasonable estimates, the QJSA explanation must include a statement regarding the participant’s right to obtain a more precise calculation of relative value or financial effect upon request. For example, a participant may request a calculation that takes into account the actual age of his or her spouse. If a participant requests a precise calculation, and the calculation materially changes the relative value of any optional form, the revised relative value of that optional form must be disclosed.
Financial Effect Explanations for Defined Contribution Plans
Explanations of financial effect for defined contribution plans that provide annuity forms of benefit must include a statement that the annuity will be provided through the purchase of an annuity contract from an insurance company with the participant’s account balance under the plan. If the explanation is prepared using estimates, the use of such estimates must also be disclosed.
Generalized ExplanationsAs referenced above, plans may provide generalized explanations of each optional form of benefit available to a participant in lieu of explanations that are specific to the participant. Such explanations, however, must include:
- the actual benefit payable to the participant under the normal form of benefit or the amount payable under the normal form of benefit adjusted for immediate commencement; and
- a statement regarding the participant’s right to obtain a personalized statement of the financial effect of electing an optional form of benefit and a comparison of relative values under each available optional form.
The generalized explanation may use a chart showing the financial effect and relative value of the optional forms of benefit in a series of examples specifying the amount payable to a hypothetical participant at representative ages. Such a chart must be accompanied by a general statement describing the effect of significant variations between the assumed ages, or other variables, on the financial consequences of electing the optional form of benefit, and on the comparison of the relative value of the optional form of benefit to the value of the QJSA.
Each example must use reasonable assumptions for the age of the hypothetical participant’s spouse and any other variables that affect the financial effect or relative value of the optional form of benefit. In addition, the chart must include an explanation of the concept of relative value and the interest rates used.
QPSA ExplanationsIf a plan fully subsidizes QPSAs, the plan is not required to provide explanations to participants.
However, if a plan does not fully subsidize QPSAs, the QPSA explanation must include the following:
- a general description of the QPSA;
- the circumstances under which the QPSA will be paid if elected;
- the availability of the election of the QPSA; and
- a description of the financial effect of the election of the QPSA on the participant’s benefits (i.e., an estimate of the reduction to the participant’s estimated normal retirement benefit if the QPSA is elected).
The explanation of the financial effect of electing the QPSA may be participant-specific or may be based on a hypothetical participant. If a plan provides generalized explanations that are based on a hypothetical participant, the explanation must also include a statement regarding the participant’s right to request and receive an individualized estimate of the reduction to his or her normal retirement benefit.
Delivery of ExplanationsUnder the regulations, QJSA and QPSA explanations may be provided via first class mail to the last known address of the participant or via hand delivery. The IRS and Treasury Department are currently considering whether these explanations and other various IRS notices may be provided electronically.
ConclusionThe recently issued relative value regulations require plans to provide QJSA and QPSA explanations which are more detailed than past guidance seemed to permit. As such, defined benefit plans and money purchase pension plans may be required to amend their notices and the methods for preparing such notices in their entirety. Contact our office if you would like our assistance in complying with the regulations.
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